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FINANCIAL STATEMENTS

Qualifications and Credit Framework

AQ 2013 Level 4 Diploma in Accounting

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KAPLAN PUBLISHING

British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library. Published by Kaplan Publishing UK Unit 2, The Business Centre Molly Millars Lane Wokingham Berkshire RG41 2QZ ISBN 978-1-78415-398-4

The text in this material and any others made available by any Kaplan Group company does not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content as the basis for any investment or other decision or in connection with any advice given to third parties. Please consult your appropriate professional adviser as necessary. Kaplan Publishing Limited and all other Kaplan group companies expressly disclaim all liability to any person in respect of any losses or other claims, whether direct, indirect, incidental, consequential or otherwise arising in relation to the use of such materials. © Kaplan Financial Limited, 2015

Printed and bound in Great Britain.

We are grateful to the Association of Accounting Technicians for permission to reproduce past assessment materials and example tasks based on the new syllabus. The solutions to past answers and similar activities in the style of the new syllabus have been prepared by Kaplan Publishing.

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of Kaplan Publishing.

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CONTENTS Introduction v

Unit guide vii

The assessment xix

Study skills xxi

Terminology IFRS and UK GAAP xxv

STUDY TEXT AND WORKBOOK

Chapter

Study text

Workbook Activities Answers

1 Regulatory frameworks

1 –

2 The conceptual framework

9 301

3 Property, plant and equipment

31 305

4 Intangible assets

43 308

5 Impairments

51 309

6 Inventories

57 309

7 Taxation

67 –

8 Leases

73 310

9 Events after the reporting period, provisions and contingencies

85 311

10 Revenue

97 –

11 Company finance

103 –

12 Company financial statements

113 312

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13 Statement of cash flows

159 319

14 Interpretation of financial statements

195 325

15 Consolidated statement of financial position

225 338

16 Consolidated statement of profit or loss

269 344

17 Consolidated accounts: parents, subsidiaries and associates

293 –

Mock Assessment Questions

351

Mock Assessment Answers

359

Index

I.1

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INTRODUCTION

HOW TO USE THESE MATERIALS

These Kaplan Publishing learning materials have been carefully designed to make your learning experience as easy as possible and to give you the best chance of success in your AAT assessments.

They contain a number of features to help you in the study process.

The sections on the Unit Guide, the Assessment and Study Skills should be read before you commence your studies.

They are designed to familiarise you with the nature and content of the assessment and to give you tips on how best to approach your studies.

STUDY TEXT

This study text has been specially prepared for the revised AAT qualification introduced in 2013.

It is written in a practical and interactive style:

• key terms and concepts are clearly defined

• all topics are illustrated with practical examples with clearly worked solutions based on sample tasks provided by the AAT in the new examining style

• frequent practice activities throughout the chapters ensure that what you have learnt is regularly reinforced

• ‘pitfalls’ and ‘examination tips’ help you avoid commonly made mistakes and help you focus on what is required to perform well in your examination

• clear advice as to which practice activities can be completed is given at the end of each chapter.

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WORKBOOK

The workbook contains practice activities with solutions to reinforce the work covered in each chapter.

The questions are divided into their relevant chapters and students may either attempt these questions as they work through the textbook, or leave some or all of these until they have completed the textbook as a final revision of what they have studied.

ICONS

The study chapters include the following icons throughout.

They are designed to assist you in your studies by identifying key definitions and the points at which you can test yourself on the knowledge gained.

Definition

These sections explain important areas of knowledge which must be understood and reproduced in an assessment.

Example

The illustrative examples can be used to help develop an understanding of topics before attempting the activity exercises.

Activity

These are exercises which give the opportunity to assess your understanding of all the assessment areas.

Quality and accuracy are of the utmost importance to us so if you spot an error in any of our products, please send an email to [email protected] with full details, or follow the link to the feedback form in MyKaplan.

Our Quality Co-ordinator will work with our technical team to verify the error and take action to ensure it is corrected in future editions.

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UNIT GUIDE

Purpose of the unit

The AAT has stated that the general purpose of this unit is to enable learners to demonstrate that they possess the requisite knowledge and skills to be able to accurately draft singular and consolidated financial statements of limited companies, and analyse and interpret the financial statements of limited companies using ratio analysis.

Learning objectives

On completion of these units the learner will be able to:

• understand the regulatory framework that underpins financial reporting

• understand the key features of a published set of accounts

• understand basic principles of consolidation

• appreciate the analysis and interpretation of financial statements

• draft statutory financial statements for a limited company

• draft simple consolidated financial statements

• interpret financial statements using ratio analysis.

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Learning outcomes and assessment criteria

The unit consists of five learning outcomes. The learner will be able to:

1 Understand the regulatory framework that underpins financial reporting

2 Understand the key features of a published set of accounts

3 Draft statutory financial statements for a limited company

4 Draft consolidated financial statements

5 Interpret financial statements using ratio analysis.

There is a number of assessment criteria linked to each learning outcome.

Chapter 1 Understand the regulatory framework that

underpins financial reporting

1.1 Explain the scope, elements and purpose, for different users, of preparing financial statements for external reporting

1, 2

1.2 Describe legislation and regulation which must be complied with in the preparation of the financial statements

1, 2, 11, 12

1.3 Explain the reason for governance by legislation and regulation

1

1.4 Explain the relevance of accounting standards 1

1.5 Explain the duties and responsibilities of the directors or other responsible parties, of a corporate organisation

1, 2, 11

2 Understand the key features of a published set of accounts

2.1 Describe the key components and the purpose of a statement of financial position

12

2.2 Describe the key components and the purpose of a statement of profit or loss and other comprehensive income

12

2.3 Describe the key components and the purpose of a statement of cash flows

13

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Chapter 2.4 Explain the content and purpose of disclosure notes to

the accounts 12

2.5 Identify accounting standards and the effect of these on the preparation of the financial statements

3 – 13, 17

3 Draft statutory financial statements for a limited company

3.1 Apply accounting standards and relevant legislation to correctly identify, and accurately adjust, accounting information

3 – 13

3.2 Use appropriate information to draft a statement of profit or loss and other comprehensive income

12

3.3 Use appropriate information to draft a statement of financial position

12

3.4 Prepare notes to the financial statements which satisfy current statutory disclosure requirements, in respect of accounting policies, non-current assets, current and non-current liabilities and equity

3 – 13

3.5 Draft a statement of cash flows 13

4 Understand the basic principles of consolidation

4.1 Describe the key components of a set of consolidated financial statements – parent, subsidiary, non-controlling interest, goodwill, fair values, pre and post acquisition profits and equity

15, 16

4.2 Explain the process of basic consolidation for a parent and subsidiary

15 – 17

4.3 Describe the effect of consolidation on each of the key elements – parent, subsidiary, non-controlling interest, goodwill, fair values, pre and post acquisition profits and equity

15, 16

4.4 Explain the key features of a parent/associate relationship

17

4.5 Draft a consolidated statement of profit or loss for a parent company with one partly owned associate in accordance with current accounting standards

16

4.6 Draft a consolidated statement of financial position for a parent company with one partly owned subsidiary in accordance with accounting standards

15

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Chapter 5 Appreciate the analysis and interpretation of

financial statements

5.1 Explain the relationship between elements of the financial statements – assets, liabilities, income, expenses, contributions from owners and distributions to owners

2

5.2 Discuss the purpose of interpreting ratios in a business environment

14

5.3 Use accounting ratios to calculate and interpret the relationship between elements of the financial statements with regard to profitability, liquidity, efficient use of resources and financial position

14

5.4 Draw valid conclusions from the information contained within the financial statements

14

5.5 Present clearly and concisely issues, analysis and conclusions to the appropriate people

14

Delivery guidance

The AAT have provided a comprehensive content guide for the unit in respect of the international financial reporting standards (both IFRS and IAS) which are assessable. The content that is assessable is described under each of the headings.

IFRS 3 – Business combinations • definitions of acquiree, acquirer, business, business combination,

control, fair value, goodwill, identifiable, non-controlling interest (Appendix A)

• identifying a business combination (3 and Appendix B5)

• the acquisition method (4 and 5), identifying the acquirer (6 and 7), determining the acquisition date (8 and 9), recognition and measurement of assets, liabilities and non-controlling interest (10 – 12)

• measurement principle (18 and 19)

• recognition and measurement of goodwill (32, 34, and 35).

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IFRS 10 – Consolidated Financial Statements • Requirement to present consolidated financial statements (4) and

definition of consolidated financial statements (Appendix A) • Assessment of whether an entity controls an investee (5 – 7) • Explanations of power (10), returns (15), and the link between power

and returns (17) • Need to use uniform accounting policies in consolidation (19) • Consolidation procedures (B86)

• Presentation of non-controlling interests (22)

IAS 1 – Presentation of financial statements • Purpose of financial statements (9) • Complete set of financial statements (10, 10A and 11) • requirement for financial statements to present fairly the financial

position, financial performance and cash flows of an entity (15) • requirement to make a statement in respect of compliance with

IFRS (16)

• requirement to assess going concern (25)

• requirement for accrual accounting (27)

• requirement to present each material class of similar items separately (29)

• prohibition of offsetting elements (32)

• requirement to present a complete set of financial statements at least annually (36)

• requirement for comparative information (38)

• requirement for consistency of presentation and classification (45)

• requirement to identify clearly the financial statements (49) and each component of the financial statements (51)

• requirement to display other information prominently (51)

• information to be presented on the face of the statement of financial position (54 and 55)

• requirement to separate current and non-current assets and liabilities (60)

• criteria for current assets (66) and current liabilities (69)

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• sub-classifications on the face of the statement of financial position or in notes (77 and 78) and disclosure of other items on the face of the statement of financial position or the statement of changes in equity or in notes (79)

• information to be presented on the face of the statement of profit or loss and other comprehensive income (82 – 85)

• prohibition of extraordinary items (87)

• separate disclosure of material items of income and expense (97)

• requirement to analyse expenses based on nature of expenses or their function (99) and criteria of choice (99, 105) with examples of analysis in 102 – 103). [Only the form of analysis based upon functionality will be assessed]

• requirement to present a statement of changes in equity (106)

• information to be shown in the statement of changes of equity (106) and the treatment of dividends (107)

• general requirements for notes (112), cross referencing (113), disclosure of accounting policies (117) and disclosure of dividends proposed (137).

IAS 2 – Inventories

• definition of inventories (6)

• measurement of inventories (9) and definition of net realisable value (6)

• what is included in cost of inventories (10 and 15) and what is excluded (16)

• cost of inventories of items that are not ordinarily interchangeable (23)

• formulas that are to be used to determine the cost of inventories of items that are ordinarily interchangeable (25) and explanations of the FIFO formula and the weighted average cost formula (27).

• Examples of situations that could affect the ability of an entity to recover the cost of inventories (28) and the basis by which inventories are to be written down to net realisable value (29)

• recognition as an expense when inventories sold (34).

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IAS 7 – Statement of cash flows

• requirement for an entity to prepare a statement of cash flows in accordance with this standard (1)

• definitions of terms used in standard (6)

• requirement to report cash flows during the period classified by operating, investing and financing activities (10)

• examples of cash flows from operating activities (14)

• examples of investing activities (16)

• examples of financing activities (17)

• requirement to report cash flows from operating activities using either the direct method or the indirect method (18). Examples of both types of statement can be found in the illustrative examples which accompany the standard

• determination of the net cash flow from operating activities in accordance with the indirect method (20)

• requirement to report separately major classes of gross cash receipts and gross cash payments arising from investing and financing activities (21)

• requirement to disclose separately cash flows from interest and dividends received and paid in a consistent manner from period to period as either operating, investing or financing activities (31)

• requirement to disclose separately cash flows from taxes on income as cash flows from operating activities unless they can be specifically identified with financing and investing activities (35)

• disclosure of components of cash and cash equivalents and the reconciliation of the amounts in the statement of cash flows with the equivalent items reported in the statement of financial position (45).

IAS 10 – Events after the reporting period

• definitions of events after the reporting period and adjusting and non- adjusting events (3)

• requirement to adjust for adjusting events after the reporting period (8) with examples (9)

• prohibition of adjustment in respect of non-adjusting events after the reporting period (10) with examples (11)

• prohibition on recognition of dividends declared after the reporting period as a liability (12)

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• prohibition on preparing financial statements on a going concern basis if there is an intention to liquidate or cease trading (14)

• requirement to disclose date when financial statements were authorised for issue (17)

• requirement to disclose material non-adjusting events (21) with examples (22).

IAS 12 – Income taxes

• [Students need only be able to identify the amount of tax that needs to be recognised in the statement of financial position and the statement of profit or loss in respect of profit for the year, and account for any adjustments in respect of over or under-estimated tax of prior periods. Students will not be required to perform a tax computation or account for deferred tax].

IAS 16 – Property, plant and equipment

• definition of property, plant and equipment (6)

• recognition rule for items of property, plant and equipment (7)

• recognition rules for subsequent expenditure (12, 13 and 14)

• measurement rule at recognition (15) and of elements of cost (16, 17 and 19)

• measurement rules after recognition (29) including explanation of cost model (30) and revaluation model (31)

• rules on frequency of revaluations (34)

• rule that all assets belonging to a class must be revalued if one item in that class is revalued (36) and examples of different classes (37)

• treatment of revaluation surpluses or decreases (39 and 40)

• requirement to depreciate each part of an item of property, plant and equipment separately (43)

• depreciation charge for each period to be recognised in profit or loss (48)

• depreciable amount to be allocated on a systematic basis over the asset’s useful life (50)

• requirement to review the residual value at least at the year end and any change to be accounted for as a change in accounting estimate

• rule that depreciation is required even if fair value exceeds carrying amount as long as the residual value does not exceed its carrying amount, in which case depreciation is zero, and not negated by repair and maintenance (52)

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• depreciable amount determined after deducting residual value (53)

• factors determining useful life of an asset (56)

• land not depreciated (58)

• rule for determining depreciation method (60) with examples of methods (62) and need for review at least at the year end (61)

• derecognition rule (67)

• treatment of gain and loss (68) and how computed (71)

• disclosure relating to each class of property, plant and equipment (73), depreciation method and useful life or depreciation rates, depreciation and accumulated depreciation (75).

IAS 17 – Leases

• classification of leases as finance and operating leases (8) and examples of situations in which a lease would be classified as a finance lease (10 and 11)

• application of distinction between operating and finance leases to leasing of land and buildings (14 and 15)

• initial recognition of finance leases of lessees (20) including related definitions of fair value, minimum lease payments, interest rate implicit in lease and incremental borrowing rate (4)

• subsequent measurement of finance leases of lessees (25 and 26)

• requirement to depreciate assets held under finance leases of lessees (27) including definition of useful life (4)

• accounting requirements for operating leases of lessees (33)

• [Simple computational questions may be set in relation to the accounting of leases for lessees. Accounting for leases in respect of lessors is not assessable].

IAS 18 – Revenue

• scope of standard (1)

• definitions of revenue and fair value (7)

• Value added taxes are excluded from revenue (8)

• measurement of revenue (9)

• conditions for recognising revenue from the sale of goods (14), rendering of services (20) and dividends (29 and 30).

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IAS 28 – Investments in associates and joint ventures

• definitions of terms used in standard (3)

• criteria for significant influence (6 and 7)

• requirement to account for associates using the equity method (16) and description of that method (10)

• need to used uniform accounting policies in applying the equity method (35 and 26).

• [Students will not be required to draft financial statements using the equity method, but they must have an understanding of the key features of a parent/associate relationship as specified above. The accounting treatment of investments in joint ventures is not assessable.]

IAS 36 – Impairment of assets

• Definitions of carrying amount, recoverable amount, fair value, value in use and impairment loss (6)

• an asset is impaired when its carrying amount exceeds its recoverable amount (8)

• Requirement to assess whether there is any indication that an asset may be impaired and requirement to estimate the recoverable amount when such an indication exists (9)

• requirement to assess intangible assets with an indefinite useful life and goodwill annually (10)

• indications of impairment (12, 13 and 14)

• explanations of how to determine fair value less costs to sell (25, 26, 27 and 28)

• recognising and measuring an impairment loss for in individual assets other than goodwill (59 and 60) and revision of depreciation charge (63)

• disclosure of impairment loss recognised in profit or loss and other comprehensive income (126a and c).

IAS 37 – Provisions, contingent liabilities and contingent assets

• Definitions (not onerous contracts or restructuring) (10)

• distinction between provisions and other liabilities (11), idea of being contingent in the standard (12) and distinction between provisions and contingent liabilities (13)

• requirement to recognise provisions and criteria (14)

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• prohibition on recognising contingent liabilities (27) and contingent assets (31)

• measurement of provision (36 and 37)

• requirement to review provisions at the end of each reporting period to reflect current best estimate (59)

• use of provisions (61)

• disclosure of provisions (84 – 85)

• disclosure of contingent liabilities (86) and contingent assets (89).

IAS 38 – Intangible assets

• definition of an intangible asset, research and development (8)

• identifiability criterion in definition of an intangible asset (12)

• recognition criteria for intangible assets (21) including explanation of future economic benefits (17)

• measurement rule for intangible assets (24)

• prohibition on recognition of internally generated goodwill (48)

• rules of recognition of internally generated intangible assets including the need to classify the generation of the asset into a research phase and a development phase (52 and 53); the accounting treatment of expenditure incurred in the research phase of a project (54) and examples of research activities (56); the accounting treatment of expenditure incurred in the development phase of a project (57) and examples of development activities (59)

• prohibition of the recognition of internally generated brands and similar items (63)

• need to determine whether useful life of an intangible asset is finite or indefinite (88)

• rules for depreciation of intangible assets with finite useful lives (97), residual value (100) and review of amortisation period (104)

• prohibition of amortisation for intangible assets with indefinite useful life (107) and requirement for impairment review in accord with IAS 36 (108) and review of useful life assessment (109).

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THE ASSESSMENT

The format of the assessment

The assessment will be divided into eight tasks.

Task Max marks Topic 1

40 Draft statutory financial statements for a limited company 2

3 22

Conceptual and regulatory frameworks, and International Financial Reporting Standards 4

5 17 International Financial Reporting Standards

6 28 Consolidated Financial Statements

7 20 Analysis and interpretation of financial statements (ratio formulas and calculations)

8 23 Analysis and interpretation of financial statements (written element)

Learners will be assessed by computer based assessment (CBA), which will include extended writing tasks.

Time allowed

The time allowed for this assessment is two and half hours.

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STUDY SKILLS

Preparing to study

Devise a study plan Determine which times of the week you will study.

Split these times into sessions of at least one hour for study of new material. Any shorter periods could be used for revision or practice.

Put the times you plan to study onto a study plan for the weeks from now until the assessment and set yourself targets for each period of study – in your sessions make sure you cover the whole course, activities and the associated questions in the workbook at the back of the manual.

If you are studying more than one unit at a time, try to vary your subjects as this can help to keep you interested and see subjects as part of wider knowledge.

When working through your course, compare your progress with your plan and, if necessary, re-plan your work (perhaps including extra sessions) or, if you are ahead, do some extra revision/practice questions.

Effective studying

Active reading You are not expected to learn the text by rote, rather, you must understand what you are reading and be able to use it to pass the assessment and develop good practice.

A good technique is to use SQ3Rs – Survey, Question, Read, Recall, Review:

1 Survey the chapter Look at the headings and read the introduction, knowledge, skills and content, so as to get an overview of what the chapter deals with.

2 Question Whilst undertaking the survey ask yourself the questions you hope the chapter will answer for you.

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3 Read Read through the chapter thoroughly working through the activities and, at the end, making sure that you can meet the learning objectives highlighted on the first page.

4 Recall At the end of each section and at the end of the chapter, try to recall the main ideas of the section/chapter without referring to the text. This is best done after a short break of a couple of minutes after the reading stage.

5 Review Check that your recall notes are correct.

You may also find it helpful to re-read the chapter to try and see the topic(s) it deals with as a whole.

Note taking Taking notes is a useful way of learning, but do not simply copy out the text.

The notes must:

• be in your own words

• be concise

• cover the key points

• be well organised

• be modified as you study further chapters in this text or in related ones.

Trying to summarise a chapter without referring to the text can be a useful way of determining which areas you know and which you don’t.

Three ways of taking notes 1 Summarise the key points of a chapter 2 Make linear notes

A list of headings, subdivided with sub-headings listing the key points.

If you use linear notes, you can use different colours to highlight key points and keep topic areas together.

Use plenty of space to make your notes easy to use.

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3 Try a diagrammatic form The most common of which is a mind map.

To make a mind map, put the main heading in the centre of the paper and put a circle around it.

Draw lines radiating from this to the main sub-headings which again have circles around them.

Continue the process from the sub-headings to sub-sub-headings.

Highlighting and underlining You may find it useful to underline or highlight key points in your study text – but do be selective.

You may also wish to make notes in the margins.

Revision phase

Kaplan has produced material specifically designed for your final examination preparation for this unit.

These include pocket revision notes and a bank of revision questions specifically in the style of the new syllabus.

Further guidance on how to approach the final stage of your studies is given in these materials.

Further reading

In addition to this text, you should also read the ‘Student section’ of the ‘Accounting Technician’ magazine every month to keep abreast of any guidance from the examiners.

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TERMINOLOGY IFRS AND UK GAAP As of 1 January 2012 AAT will solely examine terminology consistent with IFRS and will no longer examine UK GAAP specific terminology.

The list shown gives the ‘translation’ between UK GAAP and IFRS. Although this is not a comprehensive list, it does cover the main terms that you will come across in your studies and assessments.

UK GAAP IFRS Final accounts Financial statements Trading and profit and loss account Statement of profit or loss Turnover or Sales Revenue or Sales Revenue Interest payable Finance costs Bad debt expense Irrecoverable debt expense Operating profit Profit from operations Net profit/loss Profit/Loss for the year/period Balance sheet Statement of financial position Fixed assets Non-current assets Net book value Carrying amount Tangible assets Property, plant and equipment Depreciation/Depreciation expense(s) Depreciation charge(s) Stocks Inventories Trade debtors or Debtors Trade receivables or Receivables Debtors ledger control account Sales ledger control account

Receivables ledger control account Sales ledger control account

Provision for doubtful debts Allowance for doubtful debts Debtors and prepayments Trade and other receivables Cash at bank and in hand Cash and cash equivalents Trade creditors or Creditors Trade payables or Payables Creditors ledger control account Purchase ledger control account

Payables ledger control account Purchase ledger control account

Creditors and accruals Trade and other payables Long-term liabilities Non-current liabilities Profit and loss balance Retained earnings VAT/Sales tax VAT/Sales tax

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Introduction In this initial chapter we will be covering background information that is essential for your understanding of the preparation of financial statements for many types of organisation, in particular for limited companies.

LEARNING OUTCOMES

Explain the scope, elements, and purpose, for different users, when preparing financial statements for external reporting (1.1)

Describe the legislation and regulation which must be complied with in the preparation of financial statements (1.2)

Explain the reasons for governance by legislation and regulation (1.3)

Explain the relevance of accounting standards (1.4)

Explain the duties and responsibilities of the directors of a corporate organisation (1.5)

CONTENTS

1 Introduction 2 The purpose of

financial statements 3 The legal framework 4 Accounting standards

Regulatory frameworks

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Regulatory frameworks: Chapter 1

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1 Introduction

1.1 Background knowledge In previous units your accounting studies took you from ledger accounts to a trial balance to an extended trial balance. On the extended trial balance you will have put through a number of adjustments for inventories, accruals, prepayments, depreciation and irrecoverable and doubtful debts. Each account on the extended trial balance was then balanced and extended into either the statement of profit or loss columns or the statement of financial position columns depending upon whether the balance was income, expenditure, an asset or a liability.

For this unit your accounting knowledge must be taken further.

1.2 Drafting financial statements This unit involves the drafting of the relevant financial statements for limited companies. You must be able to prepare a statement of financial position, statement of profit or loss and other comprehensive income, statement of changes in equity and statement of cash flow in accordance with all the applicable regulations (the Companies Act 2006, accounting standards, etc).

1.3 Interpretation of financial statements The unit also involves interpretation of limited company financial state-ments. It is concerned with being able to analyse and understand the structure and purpose of financial statements of limited companies. It requires a sound understanding of the knowledge and skills required to prepare financial statements and an ability to interpret the relationships between these elements of financial statements by using ratio analysis.

In order to understand and interpret limited company financial statements you must be able to understand how they have been prepared. Therefore your knowledge of accounts preparation I and accounts preparation II is extremely important as the knowledge and skills from these units will assist in the understanding of how the financial statements of limited companies are prepared.

In this chapter and the next, however, we will consider the background to the preparation of financial statements for limited companies by considering the regulatory framework and then the conceptual framework within which these financial statements must be prepared.

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2 The purpose of financial statements

2.1 Introduction The main purpose of financial statements is to provide information to a wide range of users. The statement of financial position provides information on the financial position of a business (its assets and liabilities at a point in time). The statement of profit or loss and other comprehensive income provides information on the performance of a business (the profit or loss which results from trading over a period of time) as well as gains or losses that are not recognised in profit or loss. The statement of changes in equity provides information about how the equity of the company has changed over the period. The statement of cash flow provides information on the financial adaptability of a business (the movement of cash into and out of the business over a period of time).

2.2 Stewardship Financial statements also show the results of the stewardship of an organisation. Stewardship is the accountability of management for the resources entrusted to it by the owners or the Government. This applies to the financial statements of limited companies as well as to central and local government and the National Health Service.

2.3 Needs of users All users of financial statements need information on financial position, performance and financial adaptability. However, many different groups of people may use financial statements and each group will need particular information. Users of financial statements may include investors, management, employees, customers, suppliers, lenders, the government and the public.

• Investors need to be able to assess the ability of a business to pay dividends and manage resources.

• Management need information with which to assess performance, take decisions, plan, and control the business.

• Lenders, such as banks, are interested in the ability of the business to pay interest and repay loans. HM Revenue and Customs uses financial statements as the basis for tax assessments.

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2.4 Legal requirements The law requires limited companies to prepare financial statements annually. These financial statements must be filed with the Registrar of Companies and are then available to all interested parties. Most businesses, whether incorporated or not, are required to produce financial statements for submission to HM Revenue and Customs. In the UK, the form and content of limited company accounts is laid down within the Companies Acts. The preparation of limited company accounts is also subject to regulations issued by the Financial Reporting Council if the company is still following UK standards or the International Accounting Standards Board if the company has adopted international standards.

3 The legal framework

3.1 Introduction The financial statements of limited companies must usually be prepared within the legal framework relevant to that company. In the case of UK companies, the Companies Act 2006 contains guidance and rules on:

• Formats for the financial statements • Fundamental accounting principles • Valuation rules. The Companies Act 2006 allows companies to use the format of accounts set out in IAS 1(revised) Presentation of Financial Statements if they have adopted IFRS or continue to use the format in the Act if they have not.

4 Accounting standards

4.1 IFRSs and IASs Accounting standards give guidance in specific areas of accounting. The Financial Statements syllabus follows International standards which consist of the following:

• International Financial Reporting Standards (IFRSs) These are issued by the International Accounting Standards Board.

Many countries have used IFRSs for some years. Back in 2002, the Council of Ministers of the European Union (EU) decided that any company which is listed on a European Stock Exchange must prepare their consolidated accounts in line with IFRSs with effect from 1 January 2005.

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International Accounting

Standards Board (IASB)

International Financial Reporting

Interpretations Committee (IFRS IC)

IFRS Foundation

IFRS Advisory Council

(IFRS AC)

• International Accounting Standards (IASs) IASs were created by a body known as the International Accounting

Standards Committee (IASC) the predecessor of the IASB. When the IASB was formed it adopted the standards of the IASC which were called IASs. In recent times, the IASB has introduced many new standards so several IASs have now been superseded.

4.2 The structure of the regulatory bodies The structure of the International Financial Reporting Standards Foundation and its subsidiary bodies is shown below:

4.3 The IFRS Foundation (‘the Foundation’) The IFRS Foundation is an independent not-for profit foundation based in the US. The Trustees of the Foundation appoint the members of the International Accounting Standards Board, the IFRS Advisory Council and the IFRS Interpretations Committee. They are also responsible for setting and approving the budgets of the various bodies, determining strategic direction and promoting IFRS.

4.4 The International Accounting Standards Board (‘the IASB’)

The IASB has sole responsibility for the setting of international accounting standards. The IASB’s objectives are: (a) to develop a single set of high quality, global accounting standards

that require transparent and comparable information in general purpose financial statements

(b) to promote the use and rigorous application of those standards, and (c) to work actively with national standard setters to bring about

convergence of national accounting standards and IFRSs.

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IFRSs set out the recognition, measurement, presentation and disclosure requirements of transactions and events that are important in accounting. They apply to all general purpose financial statements and any limitation in scope of the standard is stated within the standard.

The IASB cooperates with other accounting standard setters with the aim of achieving harmony of accounting practice throughout the world. This has been the case in the UK as the Financial Reporting Council has adopted recent IFRSs. There will be minimal difference in accounting practice for companies who have adopted IFRS and those who haven’t.

4.5 International Financial Reporting Interpretations Committee (‘IFRS IC’)

The aim of the IFRIC is to assist the IASB in establishing and improving standards of financial accounting and reporting. It promotes the rigorous and uniform application of IFRS. They provide timely guidance on:

1 newly identified financial reporting issues not specifically covered by an accounting standard

2 unsatisfactory interpretations that have developed or may develop.

The guidelines IFRIC publishes are called IFRIC Interpretations. If a company complies with IFRSs, then it is automatically presumed that this includes the IFRIC Interpretations as well as the relevant standards.

4.6 IFRS Advisory Council (‘IFRS AC’) The Council provides a forum for organisations and individuals to input into the standard setting process. Their overall objectives are:

(i) to give advice to the IASB on agenda decisions and priorities

(ii) to inform the IASB of the views of organisations and individuals, and

(iii) to give other advice to the IASB or the Trustees.

4.7 The standard setting process There are a number of steps in the process of developing and issuing a new accounting standard by the IASB. These are detailed below:

(a) Staff are asked to identify and review all issues associated with a topic and to consider the application of the Conceptual Framework to the issues

(b) Study of national accounting requirements and practice and an exchange of views about the issues with national standard-setters

(c) Consulting the Council about the advisability of adding the topic to the IASB agenda

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(d) Formation of an advisory group to give advice to the IASB on the project

(e) Publishing for public comment a discussion document

(f) Publishing for public comment an exposure draft approved by at least eight members of the IASB, including any dissenting opinions held by IASB members

(g) Publishing within an exposure draft a basis for conclusions

(h) Consideration of all comments received within the comment period on the discussion documents and exposure drafts

(i) Consideration of whether to hold a public hearing and to conduct field tests and, if necessary, holding such hearings and conducting such tests

(j) Approval of a standard by at least eight members of the IASB and inclusion in the published standard of any dissenting opinions, and

(k) Publishing within a standard a basis for conclusions, explaining, among other things the steps in the IASB due process and how the IASB dealt with public comments on the exposure draft.

Activity 1

1 What are the four statements that would be seen in a set of financial statements?

2 What is meant by the term ‘stewardship’?

3 What does IFRS stand for?

4 What is the role of the IASB?

5 What is the role of IFRIC?

5 Summary

The regulatory framework for a UK company preparing financial statements under international standards consists of:

• The Companies Act which applies to all UK companies regardless of whether they follow UK or International accounting rules

• The International Accounting Standards Board and its associated bodies who are responsible for the setting of IFRSs.

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Answers to chapter activities

Activity 1

1 Statement of financial position, statement of profit or loss and other comprehensive income, statement of changes in equity and statement of cash flow.

2 Stewardship is the accountability of management for the resources entrusted to it by the owners or the Government.

3 International Financial Reporting Standard.

4 The role of the IASB is to set accounting standards. They are called International Financial Reporting Standards.

5 IFRIC assists the IASB by producing IFRIC Interpretations which guide on new accounting issues that are not covered by an accounting standard or guide on the correct interpretation of a standard if it is being applied incorrectly.

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